The consolidation of securities and derivatives exchanges is bringing about new challenges and regulators worldwide need to work together to address these challenges, according to Martin Wheatley, CEO of Hong KongÆs Securities & Futures Commission (SFC).

ôMarkets today are de facto networks and a market is only as strong as its weakest link. When one market within the global network fails, there is a domino effect, this can create serious consequences for other markets,ö says Wheatley. He made the comments at the recent Annual Conference of International Organisation of Securities Commissions (IOSCO) in Paris.

Wheatley notes the need to stay competitive has driven the globalisation of financial markets, the removal of unnecessary regulatory hurdles and the standardisation of regulatory practices in stock and derivatives exchanges around the world. It has also led to the demutualisation of exchanges, and advances in IT and telecommunications technology.

In Asia, major stock and derivatives exchanges have demutualised and consolidated within a jurisdiction. The consolidation takes the form of a merger of the stock and derivatives markets under a holding company structure. Examples include the Hong Kong Exchanges and Clearing Limited, the Australian Securities Exchange, and the Singapore Exchange (SGX).

Given that exchanges in Asia are still generally considered entities of national or strategic importance, consolidation has not yet happened across the region, Wheatley notes.

ôThere are significant differences in legal structures, currencies, languages, political frameworks and culture across the region,ö he says. ôThese differences may make any attempt for exchange consolidation across borders more difficult.ö

However, the SGX has bought a 5% stake in the Bombay Stock Exchange of India to diversify and boost revenue growth.

In the US, more exchanges seem to be looking for mergers or acquisitions outside the US to create global exchanges.

Despite this activity, Wheatley notes that there has not been any consolidation of cash and derivatives clearing houses. Instead, the integration of trading and clearing in a vertical silo or system seems to be the preferred business model at the moment. He surmises that derivatives clearing is considerably more complex than securities clearing and, as a result, a single clearing arrangement for both cash and derivative markets will require substantial effort.

ôAll these developments introduce new regulatory challenges that require global efforts to resolve,ö Wheatley says.

First, as stock exchanges entered into the derivatives business by acquiring derivatives exchanges or introducing new products with derivatives features, the stock and derivatives markets have started to converge. In recent years, new hybrid products like derivative warrants and equity-linked structured products have become very popular in Hong Kong and in some major European markets like Germany, Switzerland, Italy and France.

ôThe convergence of the stock and derivatives markets calls for the harmonisation of regulatory requirements for the two markets and a consistent regulatory framework to ensure a level playing field,ö he says. ôIn the extreme, the convergence of the two markets may also call for the establishment of a single regulator for the stock and derivatives markets that is considered to be in a better position to supervise and monitor effectively cross-market activities, detect and prevent cross-market manipulation, and establish and coordinate cross-market contingency plans.ö

There is no single correct approach to deal with the challenges arising from the consolidation of exchanges, Wheatley stresses. He notes, however, that regulators should continue to explore the possibilities for greater convergence as markets become more consolidated and global.

ôIn areas where regulatory convergence is considered inappropriate, regulators should seek enhancements in regulatory cooperation. Regulators should enhance information sharing arrangements to cope with enforcement issues and market oversight of exchange operations,ö he says.